Proposed regs. relating to the retail-inventory method.

• Author: Watkins, Tracy

The IRS issued proposed regulations (REG-125949-10) relating to the retail-inventory method of accounting. The proposed regulations restate and clarify the computation of ending inventory values under the retail-inventory method and provide special rules for taxpayers that receive margin protection payments and similar vendor allowances.

Background

In general, the retail-inventory method regulations of Regs. Sec. 1.471-8 allow retailers to approximate (1) cost (retail-cost method) or (2) cost or market, whichever is lower (retail-LCM method), by multiplying the retail selling price of ending inventory by the cost-to-retail ratio. The cost-to-retail ratio compares (1) the cost of beginning inventory plus the cost of purchases to (2) the retail selling price of beginning inventory plus the initial retail selling price of purchases, with certain adjustments for markups and markdowns. A LIFO taxpayer that elects to use the retail-inventory method must approximate costs.

Regs. Sec. 1.471-3 currently provides that the invoice price less trade or other discounts is considered in determining the cost of inventory purchased during the year. Prop. Regs. Sec. 1.471-3(e), however, provides that an allowance, discount, or price rebate a taxpayer earns by selling specific merchandise is a reduction in the cost of goods sold and does not reduce the inventory cost or value of inventory at the end of the year.

The Proposed Regs.

In addition to restating and restructuring the regulations under Regs. Sec. 1.471-8, the proposed regulations add rules addressing the treatment of sales-based vendor allowances, vendor mark-down allowances, and margin protection payments.

Sales-based vendor allowances: The proposed regulations clarify the interaction of Prop. Regs. Sec. 1.471-3(e) with the retail-inventory method. The proposed regulations exclude sales-based vendor allowances from the numerator (the cost of beginning inventory and the cost of purchases) of the cost-to-retail ratio.

Cost-to-retail ratio under the retail-LCM method: The preamble to the proposed regulations explains that, under the retail-LCM method, a reduction in retail selling price reduces the value of ending inventory in the same ratio as the cost-to-retail ratio. If a taxpayer earns an allowance, discount, or price rebate, the inventory costs in the numerator (the cost of beginning inventory and the cost of purchases) of the cost-to-retail ratio declines, resulting in a reduction of the value...